Saturday, August 05, 2017
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Mojmír Hampl is one of the 7 members of the Czech National Bank's board – which determines the main interest rates in Czechia etc. He was the key hawk-turn-dove in 2013 whose vote decided about the interventions against the previously strengthening crown and the alleged deflation threat. And he's arguably the most outspoken pundit among the seven. I've had a lunch with him some years ago.

It was published on the Czech National Bank's website – and elsewhere. Others in the board probably agree with him. By the "fear", Hampl means that the cryptocurrencies don't really represent any "competitor" to the fiat currencies. In particular, the Czech crown – the currency only used by 0.15% of the people on Earth – is used in a 6 times larger volume of transactions than the Bitcoin – almost 50% of the cryptocurrencies' capitalization over $100 billion and a global mania.

The key reason why the cryptocurrencies aren't really competitive with the fiat currencies is that they lack what is perhaps the most important defining virtue of any currency: its predictable value relatively to the things that people will need to buy for them, the reason why they accept and hold the currencies in the first place. I wrote these things many times.

Hampl says that the price stability is also the main task of the central banks like his. In particular, when he asks the people what's the "money supply" in Czechia, people usually don't have a clue but they more or less know what the latest inflation rate is. That's because the latter is much more important for the usability of the currency than the former!

The physics analogy – and it's more than an analogy – that I always use are intensive and extensive quantities in thermodynamics; and the grand canonical and microcanonical ensemble in statistical physics.

The money supply is analogous to the "total energy carried by vibrations in a liter of water"; the inflation rate is analogous to the temperature of the water or the rate of its increase. Well, the temperature is much more important to know when you deal with the water – e.g. when you want to drink it or touch it. The total energy may be a small or big number in some units you have no idea about. It doesn't affect you. It is proportional to the volume of the water in the pot but you don't care about it too much because you will only touch the surface of the water, anyway.

A funny thing about the temperature and the inflation rate is that "everyone who is in thermal equilibrium or cooperating with the rest of the economy" is using the same value. The thermalization takes place – it brings all the players to the same temperature. The inflation rate is "shared" pretty much by definition – it's defined by a shared definition – but its being universal also has some reason. People plan the future value of the money which will be determined by some random counterparties in the market. And those will be pretty much the same people for everybody, namely statistically random people.

The microcanonical ensemble is one that tries to keep extensive quantities like the total energy of the water in the pot constant and well-defined; the grand canonical keeps the intensive quantities, such as the temperature and chemical potential, fixed. The latter are analogous to the inflation rate and the central banks keep these universal, shared, intensive quantities fixed. They often adjust the money supply or perform asset purchases in order to achieve that – exactly because the predictable value of the money, like the predictable temperature in the future, is what is needed to live there.

On the other hand, the Bitcoin wants to keep the number of Bitcoins constant – it's like keeping the total energy or the number of molecules \(E,N\) fixed in a microcanonical ensemble. It's not terribly helpful for planning how to use the Bitcoins in an actual practical life. The Bitcoin kids often tell you that the Bitcoin is "scarce" because the total number of the Bitcoins is only converging towards the upper bound, 21 million.

But the previous statement is completely vacuous. The number 21 million only has this value because we focused on a particular unit, one Bitcoin. But that unit is over $3,000 now so it isn't terribly practical to buy things every day. Instead, we could be talking about milliBitcoins. And there will be 21 billion of them – this number is no longer so small and exclusive. ;-) If the price of one Bitcoin continued to grow insanely, one microBitcoin could be a better measure in the future, and there would be 21 trillion of them, and so on. Funnily enough, these tiny fractions aren't just hypothetical. The Bitcoin folks actually use one Satoshi which is 10 nanoBitcoins, the smallest unit they may distinguish right now. There will be 2.1 quadrillions of them in the world, not so exclusive.

In the same way, the total money supply of U.S. dollars is some large number but the fact that the number is large simply doesn't pose any threat for anybody. It's some inconsequential extensive number. The number is large because there are many Americans, they have a pretty big debt, and much of the money supply is sitting somewhere, so the larger types of money supply are even larger, and so on. The energy of a liter of water in electronvolts is also large and the large number doesn't mean anything bad or anything good. It's just inconsequential. All of us live "locally" in some environment so we're primarily interested in the intensive quantities describing the conditions at the place of the environment, e.g. the inflation rate in the relevant national currency.

The fact that the number of Bitcoins in circulation is known – and will go towards 21 million – implies that the amount of "real things" in the inflation basket you may buy for one Bitcoin is not predictable. And that's bad. The kids who spread the Bitcoin and blockchain ideas as a gospel may understand some technical algorithms but they don't understand something that is much more important for an economic proposal – basics of economics. The central banks are effectively adjusting the money supply (through the interest rates or extraordinarily measures) in order to keep the money's value predictable – because the predictable value of the money is what makes them so useful and optimizes the performance of the economic players who use them in their activities and planning. So the variable money supply of a fiat currency is a good thing, not a bad thing – because it's a necessary condition for the stability of quantities whose stability or predictability is important! This stabilization of the money's value is what Hampl calls the "elastic money".

Similar texts about the key role of the price stability or predictable value for any currency have been written by the Austrian school economist Gary North, especially in late 2013. See: